World Cup may spell trouble for markets

As World Cup fever heats up, a note of caution: the world's most widely viewed sporting event could spell trouble for markets.

"For many, the soccer World Cup is a time of anxiousness and suffering, followed by chaotic collapse (usually on penalties to Germany). England fans have come to expect this but, as a client recently pointed out, the pain doesn't always stop there. Markets also suffer around World Cup time," Dario Perkins, an economist at Lombard Street Research wrote in a note.

The international football tournament, held every four years, kicks off in Brazil on June 12 and runs for four weeks.

The inaugural competition was in 1930, the first full year of the Great Depression. More recently, it coincided with the U.S. recession in 1990, a bond market crash that started in the U.S. and spread across developed markets in 1994, the Asian Financial Crisis and collapse of Connecticut-based hedge fund Long Term Capital Management (LTCM) in 1998, a U.S. housing market crash in 2006 and the beginning of the euro zone crisis in 2010.

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"The coincidences got me thinking. What could go wrong this time? Based on past episodes, we should start by looking for bubbles," said Perkins.

Abenomics - the name given to Japanese Prime Minister Shinzo Abe's economic revival plan - is one of these potential bubbles, according to Perkins.

"Aggressive monetary easing in Japan triggered a huge surge in the Nikkei and a collapse in the yen, in the expectation that the Japanese authorities could kill deflation and shift their economy onto a better medium-term growth path. But now these policies seem to be running out of steam," he said.

The benchmark Nikkei 225 has rallied over 40 percent since Abe took office in December 2012.

"With the economy slowing in response to the April tax hike and the central bank apparently unwilling to ramp up QE [quantitative easing] again, there is a risk the Abenomics effect begins to unravel," he added.

"Doubts linger about whether the economic recovery will gain traction. We think it will, but the housing market has shown a disturbingly large response to just a modest rise in mortgage rates over the past year," Perkins said.

Sales of new homes tumbled to their lowest level in eight months in March, dashing hopes for a quick turnaround for the sector.

Over the past few years, the market might have expected the Fed to respond to such an outcome by stepping up its stimulus. However, with central bank determined to end QE, the extra stimulus might not be forthcoming this time, Perkins noted.

"We could be left with a stagnant economy and a feeling of vertigo in stock markets," he added.

And last but not least, China's economy is in a precarious position.

"We are assuming a persistent slowdown in China and a gradual intensification of financial-sector pain, but after five years of credit-fuelled investment, the economy could unravel faster than we expect," he said.

Cracks in the country's real estate market - a pillar of the world's second largest economy - have started to deepen in the recent months, with home prices falling sharply in third- and fourth-tier cities as a result of excess capacity.

"These are just the risks we can identify. There are others, the 'unknown unknowns'. For instance, nobody really knows what will happen in Ukraine," he said.

"There are lots of potential outcomes and even those that fall short of World War 3 could have significant negative implications for global markets. Like the England soccer team's defense, the global financial system might be more fragile than we like to believe," he added.